Basics of Accounting and Taxes Every Landlord Should Know

You’ve spent hours researching how to set up a property for rent, the administrative side of becoming a landlord, how to cultivate good tenants, and a dozen other things you learn as a new property manager.

One thing that you might not have thought of is all the accounting you have to handle.

Chances are you don’t have your own accountant or bookkeeper to do all the day-to-day work for you, so understanding essential parts of accounting keeps you from ending up in a world of financial trouble.

Schedule E

The main thing to worry about is whether you’re about to run afoul of the IRS.

They aren’t going to look kindly on you failing to file properly, and they don’t care if you’re a first-time landlord who doesn’t know exactly what he’s doing yet.

Schedule E: Reporting Rental Income and Loss is the primary form you’re working with.

This form applies to homes from which you receive rental income, as well as renting rooms within your main residence if the length of the stay exceeds two weeks.

The easiest way to keep track of rental income is tracking tenants’ rent checks using a simple spreadsheet.

If your tenant pays through an electronic payment portal, it’s even easier to keep exact rental income records.

Deductions

Tracking rental income is simple, but it’s not as easy keeping track of all the expenses associated with the properties and whether these expenses are deductible.

Use property management software or an accounting package to keep track of expenses associated with a particular property so that you have a full list of what you can deduct from your net rental income.

Capital Gains

Another tax consideration to keep in mind is what happens when you sell one of your rental properties.

You will be required to pay capital gain taxes on profits that you receive from sale, which depends on your property’s value.

You can reduce the overall amount that you pay with deductible costs and property depreciation.

Capital gains increase if you make additions to the property.

You can avoid the capital gains tax if you’re going to use the money to buy a new property or improve an existing property.

The property has to fall under several criteria in order to qualify for a 1031 exchange, which is what this procedure is called.

Passive Income

One of the biggest adjustments to get used to when becoming a landlord, especially if you come from a salaried job, is that your income is not based on the amount of time you work.

Instead, it’s a passive income that is generated based on the properties that you hold.

While you do hands-on work with maintenance, marketing, and other activities, the amount of money you make is not related to the amount of work you put in.

Rental Property Deductions

Owning a rental property means that you are a business owner and property owner at the same time. Because of this, the owner must be aware of key rental property deductions that you can take every year to help manage your tax liabilities. It is important to remember that these deductions are not the same as depreciation, which happens to your existing structures and value improvements that occur over a specific period of time.

1. Travel Expenses Can Be Deducted

The easiest deduction to take when you travel to your rental property to care for it is the standard deduction, which gives you a certain amount per mile. You can also keep track of actual expenses over the year. Make sure to save all of your receipts and keep an odometer log.

2. Any Emergency Repairs Can Be Deducted

That phone call at 2am might not be a pleasant experience, but it is a pleasant deduction when tax time comes around. Most emergency repairs qualify as a deduction instead of for depreciation. The only exceptions would be if you had to install a new appliance, like a water heater, or a new roof instead of repairing the existing structure. This deduction includes labor.

3. Property Taxes are Always Deducted

Whatever property tax you need to pay on your property can be deducted as an expense on your taxes. In some jurisdictions, all large item taxes, including sales taxes, can also be deducted. This would mean if you replaced the water heater, you’d have to depreciate the appliance, but you might be able to deduct the sales tax.

4. Loan Expenses are Always Deductible

Anything that you need to pay in order to obtain a mortgage or a loan to help your rental property get amortized into the life of your mortgage. It is your interest that is deductible. Don’t deduct your entire mortgage payment, however, because the principal you pay down is not deductible.

5. Sometimes Lawn Care Qualifies as a Deduction

The issue at hand is whether or not the work is actually improving the value of the home. Routine lawn care, like mowing, weeding, or fertilizing are all considered expenses because it is considered maintenance. If you hire a lawn care specialist to install a retaining wall, however, this would not qualify as a deduction.

6. Losses From Theft are Always Deductible

Even if your insurance company has covered your losses, they may still be deductible if you experienced an overall financial penalty. This typically happens through the deductible on the insurance policy and if there is any value gaps between the replacements value of an item and the depreciated value of the stolen item. While you’re at it, don’t forget to deduct your insurance premiums too.

7. Fees or Assessments to Care For Common Property are Deductible

This would include HOA fees, condominium fees, or other payments that are made to help a community or a neighborhood is well-maintained. Just make sure to keep good records so that you can prove all of your deductions should questions be asked of your tax return. By doing so, you’ll be able to maximize the value of yo

The Top 5 Tax Deductions For Rental Property Owners

There are many landlords who pay more taxes than they should every year, usually because they aren’t familiar with the deductions they can claim. It takes a thorough understanding of tax law and strategic planning to take advantage of all available deductions. Here is a guide to the top five deductions you should claim.

1. Deducting Interest
Perhaps the most important deduction to take is on interest payments, which can represent a significant amount of money each year. This can cover many types of interest payments, including interest on mortgages and loans that were used to purchase or improve your rental property. These interest rate deductions also extend to credit card interest payments that were used to purchase goods or services in relation to your rental properties. Remember that this doesn’t apply to the principal that you initially paid for the property, only the interest accrued.

2. Repair Deductions
The cost of repairs can add up significantly over the year, but the good news is that these repair costs can be deducted from your taxes. Repairs to your property can take many forms:

  • Fixing leaks
  • Repainting
  • Patching a roof
  • Plumbing work
  • Replacing a broken door
  • Plastering a hole in a wall
  • Replacing a shattered window
  • and more

Be sure to keep receipts and records of all repairs you make. Also be aware that you can only deduct repair costs made the year you performed them, so be sure not to wait on this deduction until next year.

3. Travel Costs
Do you find yourself traveling constantly to repair property, pick up building supplies or meet with a tenant to discuss a problem or complaint? The great part about travel-related expenses is that they are all deductible. This even applies to overnight travel involving flights to other cities. For example, if you attend a real estate conference to help you understand how to improve your business, the plane ticket and hotel costs would also be deductible. At the same time, overnight travel is likely to be the most scrutinized by the IRS when you file your taxes, so it’s important to keep thorough records that can back up your deduction in case of an audit.

4. Depreciation Deductions
Depreciation is one deduction many landlords don’t quite understand; however, this can add up to big savings every year. The basic concept of real estate depreciation is that the IRS allows landlords to claim a “paper loss” on the value of their property. This is based on a model that stipulates that properties will lose value over 27 and a half years, which brings the value of their property from what they originally paid for it to the price of zero dollars.

Each year you can claim 2/55ths of the purchase price for 27 years. The formula for depreciation can be much more complicated and often requires an accountant for proper calculations. It’s worth the extra work, though, due to the amount of money that can deducted. Don’t forget to deduct the cost of using your accountant either, which is also permissible when it’s related to real estate activity.

5. Insurance Premiums
If you own a rental property, you’re probably paying quite a bit for insurance. This includes flood, fire, and theft insurance, as well as certain liability insurance expenses. You might even be paying for your employees’ workers compensation and health insurance. Thankfully, all of these insurance premiums are deductible.

As you can see, there are numerous deductibles available to landlords that you can use to maximize your savings. Include these five on your list of deductibles, and you’ll be doing your rental property taxes the right way.

Please note: These articles are for informational purposes and we advise you to consult an attorney for more specific information related to your situation.

Cash vs. Accrual Accounting

When you first get into property management, you will need to decide between two main accounting methods: cash and accrual. Even if you don’t have an accounting background, you will need to understand these basic principles.
There are a number of differences, but the main one is that with cash accounting, the arrangement used by most property managers, recording of transactions is done as soon as money changes hands, whether that’s money that’s coming in or going out.

For example, rent received in May will be recorded as income for May, even if it is being applied to the June rent. The same will apply to any bills you have to pay for building upkeep or utilities. Expenses are recorded when they are paid, not when the bill is received.

With accrual accounting, expenses and income are recorded as they occur, not when they are actually paid. This method is about tracking transactions rather than cash flow. Rent due on a particular date, for example, is recorded when it is due, irrespective of whether your tenants are being a little late paying or not.

Accrual Accounting Benefits

  • Because money going in and out is recorded in the same month as their due date, many argue that the resulting financial statements are more accurate and give a better idea of what to expect on future financial reports. For example, if you have paid a plumber for some work, the money is still earmarked and accounted for, even if the plumber hasn’t actually cashed the check yet. With cash accounting, the picture of long-term profit can be misleading.
  • As a property manager, you can also use accrual accounting to record other items in your financial statements, including things like long-term assets, retirement funds and staff benefit funds.
  • This method tends to suit larger property management organizations better.
  • With this methodology, a business analyst can look for financial trends while cash flow statements can also be computed regularly so that everyone stays as up to date as possible.
  • Because things are done in real time and you’re not waiting for actual receipt of cash to see your profits, you can look at ways to generate more income as you notice financial plateaus.
  • It incorporates a number of forms of error checking that may not be present in cash accounting.
  • A cash system may not provide detailed enough records for public companies and others who need to file audited financial statements.

Cash Accounting Benefits

  • Cash accounting has the great advantage of simplicity. It is an easily understood system, even by those without an accounting or financial background.
  • This system is often better for small property management businesses.
  • It gives an accurate picture of how much cash your organization has on hand at any given moment.
  • It may work well if you have no or few employees and comparatively few daily financial transactions.
  • This method can often be set up without the services of a trained accountant or bookkeeper.

Ultimately, you must be consistent with whichever method you choose. It will make a significant difference to your resulting financial statements.

Which system is right for you? It’s entirely up to you and will depend on your individual organizational needs. Whichever system you choose, you must tell the IRS and get them to approve the change if you later decide to alter systems.